Andrea Leadsom is the parliamentary candidate for South Northamptonshire and former head of Barclays' Investment Banks team, which gave her a ringside seat at the collapse of Barings Bank. Read more from Andrea on her blog.
In 1995, one month before Barings Bank collapsed as a result of rogue trading and fraud in the Far East, I was invited over to lunch with my boss at their smart London HQ. In those days I was running Barclays’ Investment Banks team and Barclays was a principal banker to Barings, doing much of their clearing banking, providing billions of trading lines and also a key lender to their global activities.
I was just 30 and had joined Barclays from the investment banking arm, BZW. Unusually for a banker, I was very familiar with treasury products, derivatives, trading etc. Also unusually for a banker, I had no formal credit or risk control background. Lunch was fabulous, cooked in-house and served in a beautiful dining room with stunning art on the walls.
My boss (Head of Barclays’ Financial Institutions Group and a traditional banker) and I were then shown round Barings’ state of the art treasury/dealing room and settlements office. The FD and Treasurer explained how their ‘world class’ treasury systems enable them to know exactly what is borrowed in each global location, what the leverage is on trading positions and where their risks are. The system could show, for example, aggregate open futures positions, their margin requirement and the source of funding from the relevant global treasury. A very interesting and convincing afternoon.
Two weeks later, there were murmurs through the markets of huge derivative losses in Barings’ Singapore office. I asked Barclays’ dealers if they could find out more and called Barings’ FD. He was unavailable, but later that day called me to ask for a large drawdown on a standby loan facility we had for them. I asked him outright – was there any truth in the rumours we were hearing – he answered outright – no, absolutely none. So after much discussion with Barclays’ credit department, we lent the money.
Within a week, it was clear the rumours were true and Barings was in deep trouble. I was about to leave the office for the weekend – 6pm on Friday evening – and a call came through from Andrew Buxton’s office (then Chairman of Barclays). My team and I spent the weekend in the office, working for Andrew Buxton and Eddie George, then Governor of the Bank of England, on two themes:
- What was Barclays’ total exposure to Barings?
- Could a consortium of banks be pulled together to underwrite Barings’ losses and thereby avoid its collapse?
There were around 20 financial institutions all working round the clock responding to the Governor’s attempt to save Barings. In the end, it proved impossible simply because over those 48 hours the potential losses could not be quantified and no financial institution would take the risk, either by buying Barings, or underwriting the losses.
So Barings was allowed to collapse. There was no systemic risk partly because the cause of the collapse was an isolated case of rogue trading, but also partly because Eddie George was firmly in control, managing the collapse once it became inevitable, and communicating one to one with key bankers.
In the end, Barings was sold to ING Bank for £1 and most other banks were able to net out their asset and liability exposures to Barings. Of course there were substantial losses to the key players and to Barclays, and also to the shareholders and employees, but the interbank system retained confidence and markets returned to normal.
As someone who was ‘in the thick of it’, I think there are several lessons to learn from the Barings story, and particularly in light of what happened more recently to Northern Rock.
First, banking is a multi-faceted and complex business. You wouldn’t expect a cancer surgeon to know all about caesarean procedures. Likewise, many lending bankers know all too little about investment banking products and vice versa. As an ex-Investment banker I could only marvel at Barings’ treasury system when in fact I should have been more challenging of its claim to provide real time global risk analysis.
I remember in the post mortem discussions about Barings that there was much hand-wringing about how every Bank’s Board needs to have derivatives expertise – in the case of Barings, even after the collapse there were board members who didn’t fully understand what had happened. There must be a responsibility on the most senior executives to understand the complex products that bring in the greatest profit and the greatest risk.
Even more important, though, is that Risk Departments of financial institutions need to have real teeth in challenging activity and setting parameters. In my years as a banker to financial institutions, there were few occasions when I was invited to meet the Head of Risk at another financial institution. Risk departments are still seen as a hindrance to profitable business, and the fact that they are often not integrated physically within the dealing environment leaves them ill informed about what is actually going on. Risk teams must be wholly integrated with their trading departments, and must have a voice at executive business meetings.
Second, we cannot in the 21st Century depend on the words ‘my word is my bond’ that sustained financial trading for so many hundreds of years. The old idea of honour and honesty are not any longer (if they ever were) core driving principles of finance. The huge growth in the volume of trading activity, the number of participants and the complexity of products make it all more impersonal.
But also, disintermediation between borrowers and lenders means there is no longer the tug of rules learned in childhood – ‘Look me in the eye and tell me the truth’… so much contact between market participants is via email and electronic exchanges; syndicated loans and asset securitisation mean there is no longer the borrower/lender relationship of the past. Honesty and transparency in financial transactions are essential – it was a couple of years after Barings’ collapse before I stopped wanting to punch the FD on the nose for lying to me!
Rules with serious penalties in the law are needed. By that I don’t mean endless turgid regulation such as we have now that ties up whole teams of staff in financial institutions just trying to interpret it. What I mean is enforced transparency between market participants to allow them to make informed decisions about the risks in trading with one another. Over dependence on ratings agencies and adherence to FSA regulations has become in recent years a substitute for thorough risk assessment between market participants.
Third, the role of the Governor of the Bank of England was crucial in the case of Barings – sorting out a banking collapse while at the same time avoiding systemic risk. Right from the outset, it was clear that the ‘buck,’ in terms of the fate of Barings and the wider market, lay in the hands of the Bank of England. And this is perhaps the most critical point: The Bank of England was both acting as Banking supervisor and as lender of last resort. Even if he wanted to, Eddie George could not have pointed a finger at anyone else to sort out the mess. Not only that, but he personally knew the key people in the City to contact when disaster struck. He made the calls and they immediately responded. The fate of Barings was sealed over a weekend.
This is a far cry from what happened with Northern Rock. The Financial Services Authority knew Northern Rock was in trouble yet allowed it to open for business anyway, thus sparking the first run on a bank in 150 years. The Bank of England could only watch as Alistair Darling also stood by, urging the public not to worry but doing nothing to take control.
I believe that responsibility and accountability are the only way to get things done. The Old Lady of Threadneedle Street fulfilled her motherly role to the financial system for many years and the system, on the whole, worked well until 1997. Labour’s decision to jump in and take away responsibility for banking supervision, giving it to the FSA, meant that the role Eddie George fulfilled during the Barings crisis could not be mirrored by Mervyn King during the Northern Rock crisis.
If you think, as I do, that confidence is the single most critical factor affecting financial markets, then you will agree that the handling of the Northern Rock crisis undermined confidence in the markets at a time of great risk, and this contributed to the speed and depth of the credit crunch.
The Bank of England must be given back its supervisory role over those financial institutions whose continued health is fundamental to the strength of our economy. If we needed to be reminded, it is now clearer than ever the devastating impact that a failure in the banking system can have across our whole society. It will take us years, if not decades, to recover from this latest crisis and we must take steps now to reverse the disastrous policy of Labour in creating the FSA.